04 Nov 2015
There is a great deal of research around investor behavior. For example, our brains notice when a group provides an answer that is different from ours, the disparity is unpleasant. For many, aligning with the group is more rewarding for the brain than being independent and correct.
Investing is not a game of perfect. It is a game of probabilities. As Ben Graham pointed out – confidence and conviction in your facts. Behaviorally, conviction is tested every day.
This past week, I came across “What’s Going On in Your Brain?” It is a high level summary of various behavioral studies. I share some of the highlights with you today.
“Buy when everyone is selling and sell when everyone else is buying” as Sir John Templeton said long ago, makes logical sense. But he added, “It will be one of the most difficult things for you to do.”
Something happens to us individuals. The tendency is to emotionally misfire at the wrong time. Still, I often hear his whisper when I find myself getting swept up in emotion created by a market move. His advice remains sound today and can be acted upon by establishing a sound process.
In recent decades, psychologists, economists, and neuroscientists have worked together to understand how our behaviors depart from the standards of normative economic theory and why exactly we have a proclivity to do so.
Scientists now have technology to observe brains of individuals as they decide and have crafted experiments to compare behaviors of people with normally functioning brains with those who had their brains altered through stroke, surgery or disease. This research has lifted the veil on the mental processes behind our choices. Some of the findings include the following:
- Humans are social and generally want to be part of the crowd. Studies of social conformity suggest that the group’s view may shape how we perceive a situation. Those individuals who remain independent show activity in a part of the brain associated with fear.
- We are natural pattern seekers and see them even where none exist. Our brains are keen to make causal inferences, which can lead to faulty conclusions.
- Standard economic theory assumes that one discount rate allows us to translate value in the future to value in the present and vice versa. Yet, humans often use a high discount rate in the short term and a low one in the long term. This may be because different parts of the brain mediate short- and long-term decisions.
- We suffer losses more than we enjoy gains of comparable size although the magnitude of loss aversion varies across the population and even for each individual based on recent experience. As a result, we sometimes forgo attractive opportunities because the fear of loss looms too large.
Conclusion: The challenge now is to create processes and procedures that manage or mitigate the biases that arise from these tendencies. (Emphasis mine )
Investment Advisor Representative